Posted on Silicon Beach by Geoff McQueen on April 1st 2009
For the benefit of people trying to do this stuff in the future, this is a short version of what I've found:
1. Granting shares directly to staff means the recipient has to pay tax when they're granted at their marginal tax rate. This isn't good for an individual's cash flow. The alternative is fringe benefits tax paid by the company, which is government endorsed extortion (now well above the top marginal tax rate, which itself doesn't kick in until much higher up the income scale than it used to). Options are less evil than shares in this respect, but there's still some evilness.
2. One solution is to use a Unit Trust. In very brief terms, the trust is set up separate to the employer, the company then lends money to the trust, usually interest free, and the trust then buys stock in the company. By issuing new stock, the company doesn't have a CGT issue to deal with (since you're not really selling existing shareholders pieces of pie, but instead growing the pie). The employees are then allocated units in this trust which are effectively stapled to the shares that the trust holds for them. Employees then, through the trust, own the shares from day one, but they're subject to a loan. You can pay dividends to the employees from day one also (not that the tech types reading this list are likely to focus on dividends).
3. Employees can then have the 'loan' owed by the trust on their behalf paid down gradually through bonuses/vesting conditions and the like.
4. When it comes time to sell the shares - because of a trade sale, other liquidity event or because the employee wants to sell them once they're paid down and they've vested - the value of the share at the issue price is taxed as if it were normal income (i.e., subject to marginal tax rates). The capital gain is taxed as CGT, and if they've held the asset for more than 12 months - which they bloody should have if you're making them vest - then they get the concessional CGT tax rate (effectively 25% of the capital gain value is then taxed as if it were normal income I believe). The important part of this principle is that they don't pay tax until they've got cash in their hands.
5. The costs for setting up the trust are tax deductible, including the costs associated with professional advice on its configuration and rules.
6. The costs for running the trust are also tax deductible.
7. You can get a private tax ruling on the trust and the scheme to ensure you don't get surprises later.
There are a bunch more models that are a variation on this that you can do too. If you're going to issue stock without vesting limits, and if you're going to issue is to more than 75% of your staff on a fairly homogenous basis, then you can issue $1000 per annum worth of shares completely tax free; that model is covered in the attachment too.
I've been getting some good advice on this from John Day at the Melbourne-based Remuneration Strategies Group. There is a file attached to this page which outlines the main options and their tax consequences.
Hope this helps someone else down the track…